RFS Advance Access published online on May 2, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp031
Financial Constraints, Investment, and the Value of Cash Holdings
Krannert Graduate School of Management, Purdue University
Sheldon B. Lubar School of Business, University of Wisconsin
Send correspondence to David J. Denis, Krannert Graduate School of Management, Purdue University, Rawls Hall, 100 S. Grant Street, West Lafayette, IN 47907-2076; telephone: 765-494-4434; fax: 765-496-7434. E-mail: djdenis{at}purdue.edu
JEL Classification: G32, G35
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Abstract |
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Previous studies report that cash holdings are more valuable for financially constrained firms than for unconstrained firms. We examine (i) why this is so and (ii) why some constrained firms appear to hold too little cash. Our results indicate that greater cash holdings are associated with higher levels of investment for constrained firms with high hedging needs and that the association between investment and value is stronger for constrained firms than for unconstrained firms. These findings imply that higher cash holdings allow constrained firms to undertake value-increasing projects that might otherwise be bypassed. We further find that some constrained firms exhibit low cash holdings because of persistently low cash flows. Overall, our findings support the view that greater cash holdings of constrained firms are a value-increasing response to costly external financing.
We appreciate helpful comments received from an anonymous referee, Murillo Campello, Diane Denis, Mara Faccio, Mike Faulkender, Stu Gillan, John McConnell, Raghu Rau, Mike Weisbach (the editor), Jin Xu, and finance seminar participants at the University of Iowa, Ohio University, and Texas Tech University.